Friday, April 28, 2017

Russia cuts rate 50 bps, inflation on target before end-'17

Russia's central bank cut its key policy rate by another 50 basis points to 9.25 percent, a move expected following its governor's statement last week, and said it now expects inflation to hit its 4.0 percent target before the end of this year. The Bank of Russia has now cut its rate twice his year by a total of 75 basis points following cuts totaling 100 points last year and 600 points in 2015 as the central bank slowly lowers its key rate that hit 17.0 percent in December 2014. Looking ahead, the central bank said it would consider the impact of oil prices on inflation and the economy but its overall assessment of the potential for further rate cuts before the end of this year was unchanged. Last week Bank of Russia Governor Elvira Nabiullina said the country's economic situation looked reassuring and faster deceleration of inflation in April to close to the bank's target had opened up the possibility of a rate cut between 25 and 50 basis points. Nabiullina's confident comments came as a surprise to many investors as the central bank in March - when it cut the rate by 25 points after a six month pause - had only said further cuts in the second and third quarters of this year were possible. In February the central bank had dampened hopes of rate cuts in the first half of this year.But Russia's inflation rate has been falling sharply, helped by a rise in the ruble's exchange rate, helping push down inflation expectations. The central bank's confidence today that inflation would hit its target before the end of this year follows its view in March that inflation would first hit 4 percent by the end of 2017. In March headline inflation fell to 4.3 percent from 4.6 percent in February and eased further to around 4.2 and 4.3 percent as of April 24, according to the central bank. "Inflation slowdown was broadly facilitated by the ruble appreciation amid relatively higher oil prices, persistent interest in investment in Russian assets among external investors, and a drop in the sovereign risk premium," the central bank said. Sluggish demand in Russia continues to keep a lid on prices as real incomes are still only showing weak growth. But the central bank said there were signs of a recovery in consumer activity and spending should gradually rise. There are no inflation risks from consumer lending, it added. But overall, the central bank expects Russia's economy to continue to recover in the first quarter of this year as investments rise, with unemployment showing a downward trend and the recovery become more even throughout the country. The central bank reiterated that it expects economic output to grow through 2019 even if oil prices drop back below $40 a barrel. Russia's economy shrank by 0.2 percent last year following a contraction of 2.8 percent in 2015 and
economists are looking for growth 1.2 percent this year.
In December the Bank of Russia forecast growth this year of 0.5 to
1.0 percent, rising to 1.5 to 2.0 percent in 2018 and 2019, if
its baseline scenario of oil prices around $40 comes true. Higher oil prices
will boost growth this year to over 1.0 percent, rising to
2.0-2.5 percent in 2018 and 2019.Russia's ruble tumbled in 2014 in response to thefall in
oil prices, its conflict in eastern Ukraine, the occupation of Crimea and
Western sanctions.

In response the
central bank drew down its international reserves to support the ruble and began
rasing rates, culminating in a stunning 650-basis-point hike in December that year to 17.0 percent.

Another
bout of volatility hit the ruble in 2015 during renewed
conflict in Ukraine's Donbass region, with the ruble's exchange
rate falling by 18 percent against the U.S. dollar in 2015 following a
45 percent plunge in 2014.

The fall in
the ruble fired up inflation, which topped 16
percent in February and March of 2015. But in late 2015 inflation started to
decelerate sharply as the economy shrank while the ruble hit a historic low of
just over 82 to the dollar in late January 2016.

Since
then the ruble has been steadily gaining strength, helping lower inflation

The
ruble was trading at 56.98 to the dollar today, up 7.6 percent this year but
still down 42.3 percent since the start of 2014.

The Bank of Russia issued the following statement:

"On 28 April 2017, the Bank of Russia Board of Directors decided to reduce the key rate to 9.25% per annum. The Board notes that inflation is moving towards the target, inflation expectations are still declining and economic activity is recovering. At the same time, inflation risks remain in place. Given the moderately tight monetary policy, the 4% inflation target will be achieved before the end of 2017 and will be maintained close to this level in 2018-2019.

In making its decision on the key rate, moving forward, the Bank of Russia will assess the probability of the baseline scenario implementation (where oil prices drop to $40 per barrel) and the scenario with rising oil prices, alongside with assessing inflation and the economy dynamics relative to the forecast. The Bank of Russia’s assessment of the overall potential of the key rate reduction before the end of 2017 is unchanged.

In making its key rate decision, the Bank of Russia was guided by the following assumptions.

Inflation dynamics. Annual inflation has moved close to the target level. Annual consumer price growth is down to 4.3% from 4.6% in February. According to the estimates as of 24 April, annual inflation stands at 4.2-4.3%. March saw a slowdown in price growth across all core groups of goods and services. Inflation slowdown was broadly facilitated by the ruble appreciation amid relatively higher oil prices, persistent interest in investment in Russian assets among external investors, and a drop in the sovereign risk premium. Seasonally adjusted monthly inflation data in February and March held at a low level. These months saw food inflation unusually low for this period, supported by the high level of supply including bumper harvests of 2015-2016. This impact is likely to run its course in the second quarter, which is attested by weekly price growth data for April that suggests that prices on fruit and vegetables accelerated. Even so, inflation is estimated to remain on the path of downward movement towards the 4% target before the end of 2017.

As inflation showed a substantial slowdown in 2017 Q1, inflation expectations of both households and businesses were down considerably. However, this trend may grind to a halt temporarily as food inflation is expected to post a seasonal increase, considering that inflation expectations are sensitive to the dynamics of this inflation.

Monetary conditions. In order to maintain the propensity to save and anchor sustainable inflation slowdown driven by demand-side restrictions, monetary conditions should remain moderately tight. Positive real interest rates are held at the level which ensures demand for loans without increasing inflationary pressure and upholds incentives for saving. A gradual decline in nominal interest rates and the easing of non-price bank lending conditions will remain. Given banks’ conservative policy stance, these trends will mostly influence high-quality borrowers.

Economic activity. The Bank of Russia estimates that the economy continued to recover in the first quarter and expects fixed capital investments to increase. Industrial production is maintaining positive dynamics and unemployment is showing a downward trend. The labour market is adjusting to the new economic environment, with signs beginning to emerge that labour shortages are finding their way in individual segments. Recovery is becoming more even across regions. Polling data reflects an improvement in business and household sentiments, supporting favourable economic dynamics. According to the Bank of Russia estimates, the observed annual rise in real wages will foster gradual growth in consumer activity without posing additional proinflationary pressure amid increased supply of goods and services.

Given the current recovery dynamics and the economy’s growing resilience to the fluctuations in the external economic climate, the Bank of Russia expects that the GDP will grow in 2017-2019 even if the conservative oil price scenario materialises.

Inflation risks. Possible volatility of global commodity and financial markets caused, among other things, by negotiations between oil exporting countries to extend agreements on limiting oil production may become the key source of inflation risks in the near future. It may result in a temporary hike in volatility of capital flows and the exchange rate undermining exchange rate and inflation expectations. That said, inflation risks will be lower in the scenario with rising oil prices. Legislative consolidation of a budget rule will also mitigate medium-term inflation risks.

Besides, medium-term inflation risks are that anchoring of inflation and inflation expectations at the target level may take a long time. This is caused by the inertia of inflation expectations and a possible shift in households’ behaviour pattern due to a decline in propensity to save.

In making its decision on the key rate, the Bank of Russia will assess the probability of the baseline scenario implementation (where oil prices drop to $40 per barrel) and the scenario with rising oil prices, alongside with assessing inflation and the economy dynamics relative to the forecast. The Bank of Russia’s assessment of the overall potential of the key rate reduction before the end of 2017 is unchanged. Given the decision taken and moderately tight monetary policy sustained, the Bank of Russia forecasts that the annual consumer price growth will reduce to 4% before the end of 2017 and will remain within this target level in 2018-2019.

The Bank of Russia Board of Directors will hold its next rate review meeting on 16 June 2017. The press release on the Bank of Russia Board’s decision is to be published at 13:30 Moscow time."